Blog Post

Market coupling does not lower prices!

Market coupling is one of the key-policies for achieving the EU single electricity market. The EU Commission praises the price-lowering effects of market integration in the first draft of the Internal Market Communication of August 30th: “wholesale electricity prices in the EU have risen much less thanks to competition facilitated by increasing cross-border trading and […]

By: Date: September 28, 2012

Market coupling is one of the key-policies for achieving the EU single electricity market. The EU Commission praises the price-lowering effects of market integration in the first draft of the Internal Market Communication of August 30th: “wholesale electricity prices in the EU have risen much less thanks to competition facilitated by increasing cross-border trading and market integration”.

And common sense would indeed suggest that in competitive markets the average price of two market zones will be equal or lower when they are coupled than when they are separate. In fact, coupling should lead to lower average prices for typical electricity markets (increasing marginal cost on the supply side and price-inelastic demand). The intuitive reason is that the most expensive MWh in the expensive country might be replaced by switching on one additional MWh in the cheaper country. As marginal cost is increasing the switched-off MWh will be disproportionally more expensive than the switched on MWh. In our example (see Figure 1) in the first market 10 MWh with marginal cost of 158-176 EUR are switched on while 10 MWh with marginal cost of 176-239 EUR are switched off.

Figure 1: Market coupling with well behaving cost functions under perfect competition

Market 1:

Marginal Cost = Volume(1.1)

Demand = 100

Market 2:

Marginal Cost = Volume(1.4)

Demand = 50

In a Cournot competition setting this effect is amplified by the increase in the number of players in the joint market. This increased competition in the joint setting will drive down prices compared to the separate market setting. In our example (see Figure 2) coupling two monopolistic markets (with similar cost curves) to one duopolistic market drives down the average price by 7 percent.

Figure 2: Market coupling with well behaving cost functions under imperfect competition

Market 1:

Cost = ½*Volume2

Demand = 300-Volume

Market 2:

Cost = ½*Volume2

Demand = 300-2xVolume

The above illustrated supply curve smoothing and competition enhancing  effect of market coupling would suggest, everything else being equal, that consumers in two markets in total face lower electricity bills when the markets are coupled, then when they are not.

We now move on to test this important proposition empirically using European spot electricity prices. The hypothesis is that at a given total demand in the two markets, average prices are typically lower when the markets are coupled than if they are decoupled. In Figure 3 the relation between load-weighted average prices (in €/MWh) in the Franco-German market and total volume (in GWh) in the Franco-German market is depicted (green dots). Thereby, the upper subplot only plots the instances were electricity prices in both countries are close to equal (price difference less than 5%) while the lower subplot restricts the sample to hours where the prices were differing by more than 5%. To make the subplots comparable the polynomial approximation to the volume-price relation has been depicted in both cases as a line.

Figure 3: Weighted average Franco-German price for coupled and decoupled hours in 2010

In Figure 4 the prices in both cases are compared. Based on the flattening supply curve and the competition effect one would expect that the red line that represents the average price when markets are decoupled is systematically higher than the blue line that represents the average price when markets are coupled (the lines are polynomial approximations to the price/volume curve). The surprising result is that price equalization (coupling) does only lead to a slightly lower average price at very high levels of electricity demand for the depicted Franco-German case.

Figure 4: Comparison of the weighted average Franco-German price for coupled and decoupled hours in 2010


 

This finding can be reproduced for many years and country combinations (see Figure 5). The only exception from this rule was the Germany-Nordic market combination in 2008 that featured significantly lower prices when the markets were coupled, than when they were not. Results are also not sensitive to the difference threshold. The figures for the 1% and 10% threshold for all 12 cases are suggesting no systematically higher price in case of decoupling like the here reported 5% threshold results.

Figure 5: Comparison of the weighted average prices for coupled and decoupled hours in various European markets

The presented findings are still very preliminary. If they can be confirmed more generally they would point to the conclusion that market coupling is much less beneficial for final customers than one might have expected. In this case, identifying the reasons why market coupling does not drive down prices is required to be able to reap the full benefits of market integration for consumers.

One possible explanation could be the sometimes unusual shapes of electricity cost curves (compared to microeconomic textbook cost curves). When moving to a cost function with a long flat left that become very steep at the right end the above outlined proposition that market coupling leads to lower average prices (due to the flattening supply curve and the competition effect) does not need to hold anymore. As illustrated in the below example (see Figure 6) the price might converge to the higher price when the more sizable low price zone is forced to accept higher prices due to coupling. More research on under which conditions to expect rising/falling prices from market coupling is necessary. This possibly needs to involve supply function equilibria to address the effects of oligopolistic competition in market integration.

Figure 6: Market coupling with non-linear cost functions under perfect competition

Just to be clear, the presented findings do not challenge the view that coupling markets is welfare enhancing. In all presented simulations, total welfare after coupling is larger or equal than in the uncoupled case. The results do also not allow deductions on additional benefits of market coupling such as potentially reduced volatility. So the sole finding I would like to put up for discussion is that market coupling might not have reduced average wholesale prices and hence did not increase consumer rents. I would encourage all readers to enlighten me on what might have caused this finding that was completely contrary to my prior expectation.

———————————————————————————————————————————————————————–

PS

Figure 7

Figure 8

Topics

Comments

Read about event More on this topic

Upcoming Event

7 
Sep
2015
10:00

Productivity, innovation and digitalisation: which global policy challenges?

How can new technologies help the global economy recover from the shocks of recent years? Can ICT and digital innovation improve productivity and create sustainable growth?

Speakers: Andrus Ansip, Robert Atkinson, Andreas Goerdeler, Scott Marcus, Eduardo Navarro de Carvalho, Karen E. Wilson and Guntram B. Wolff Topic: Innovation & Competition Policy
Read article Download PDF More on this topic

Policy Contribution

Addressing fragmentation in EU mobile telecom markets

Addressing fragmentation in EU mobile telecom markets

This Policy Contribution looks at EU mobile telecoms markets and analyses potential concrete measures to improve end-users’ access conditions and address EUmarket fragmentation.

By: Mario Mariniello and Francesco Salemi Topic: Innovation & Competition Policy Date: August 4, 2015
Read article Download PDF More on this topic

Policy Contribution

Antitrust, regulatory capture and economic integration

Antitrust, regulatory capture and economic integration

The paper investigates the distortions that national competition authorities generate when they pursue non-competitive goals in favour of domestic firms, and discusses ways to address this negative policy development in a globalised world.

By: Mario Mariniello, Damien Neven and Jorge Padilla Topic: Innovation & Competition Policy Date: July 22, 2015
Read article More on this topic

Blog Post

Mario Mariniello
Francesco Salemi

Huawei vs ZTE judgement: a welcome decision?

Today the European Court of Justice (ECJ) will rule on a dispute between Chinese tech companies Huawei and ZTE regarding a patent “essential” to the “Long Term Evolution” (LTE) wireless broadband technology standard. 

By: Mario Mariniello and Francesco Salemi Topic: Innovation & Competition Policy Date: July 15, 2015
Read article

Blog Post

Dalia Marin

Europe's Export Superstars

Germany is 'Exportweltmeister' (world champion in exporting) as it is phrased by the German media. Between 2000 and 2013 German exports increased by 154 percent compared to 127 percent in Spain, 98 percent in the UK, 79 percent in France and 72 percent in Italy. What has contributed to this exceptional export performance of Germany compared to other European countries? 

By: Dalia Marin, Jan Schymik and Jan Tscheke Topic: Innovation & Competition Policy Date: July 14, 2015
Read about event More on this topic

Past Event

Past Event

The productivity gap: why is innovation not increasing growth?

We live in an age of huge technological and commercial innovation. Yet Europe is struggling to emerge from low productivity and weak growth.

Topic: Innovation & Competition Policy Date: July 9, 2015
Read about event More on this topic

Past Event

Past Event

Collaborative innovation in the entrepreneurial ecosystem

European policymakers are currently appraising different plans to create jobs and foster economic growth. Entrepreneurship through the creation of innovative young firms is a priority.

Topic: Innovation & Competition Policy Date: June 30, 2015
Read article Download PDF More on this topic More by this author

External Publication

Policy lessons from financing innovative firms

Policy lessons from financing innovative firms

There has been increasing concern from policy makers around the world about the lack of access to finance for young innovative firms. As a result, governments in many OECD countries have sought to address the financing gap and perceived market failures by supporting the seed and early stage market.

By: Karen E. Wilson Topic: Innovation & Competition Policy Date: June 25, 2015
Read article More on this topic More by this author

Blog Post

Marek Dabrowski

The slow-reform trap

Ukraine is perhaps the most convincing example of a victim of slow reform. Since independence in 1991, it has missed several political windows of opportunity to comprehensively reform its economy and state institutions. Had these reforms been put in place, today Ukraine would be a different country. 

By: Marek Dabrowski Topic: Innovation & Competition Policy Date: June 17, 2015
Read article More by this author

Blog Post

Zsolt Darvas

Is Greece Destined to Grow?

There is much talk about the impasse between Greece and its official lenders in their bail-out negotiations, so I thought I would write about something else instead: the changes in the Greek economy towards a new growth model.

By: Zsolt Darvas Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: June 15, 2015
Read article More on this topic More by this author

Blog Post

Günther H. Oettinger's speech at Bruegel's event "What Digital Union for Europe?"

Günther H. Oettinger's speech at Bruegel's anniversary event "What Digital Union for Europe?", which took place in Warsaw on 15 June 2015.

By: Bruegel Topic: Innovation & Competition Policy Date: June 15, 2015
Read about event More on this topic

Past Event

Past Event

What digital union?

The conference in Warsaw focused on the digital economy, a topic which is often at the heart of discussions on how Europe can emerge from the economic crisis of recent years.

Topic: Innovation & Competition Policy Date: June 15, 2015
Load more posts